The Money Mustache Community
Learning, Sharing, and Teaching => Ask a Mustachian => Topic started by: Miijia on May 28, 2015, 06:02:44 AM
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Hello,
I am still in the debt pay down portion of journey to FI but the end of consumer debt is in sight and I want to start planning for the next phase. For me that is creating real emergency fund. For my purposes that means about $35,000 or a years worth of my household spending as it is today. I want to put this in an investment account but need some advice about allocations. Currently my DH and I only have investments in retirement accounts so this will be my first taxable account. So lets go over the basics of my financial situation:
Over 3 years ago DH was laid off with the rest of his department which sucked. We did not change our lifestyle right away, hence consumer debt which we are soon to be rid of, he can just get another job, right? That is what it looked like at first but about 2 months into this period a preexisting condition which he had been dealing with for years worsened greatly and at this point he is still unable to work. Again we did not change our spending right away because previously he had bounced back rather quickly. Anyway, at some point we thankfully woke up and changed our spending habits and began aggressively paying down consumer debts.
DH's illness is a big part of the reason I am seeking FI, as a SIF I feel like we need to be extra prepared, also with his illness as it stands if something happened to me he is not in a position to rejoin the workforce. If he were to decide to go for disability at that point it would be too late because the process takes forever. FI is the answer to this issue and we are working towards it now.
So here are the factors that I would like you to take into consideration:
1 Our personal situation makes having the basic emergency fund in stocks only or high stock allocation too risky for me in a short term need situation
2 The money needs to be liquid right away so using a roth and waiting five years to take out what I have put in is not an option, I am looking at taxable accounts
Questions to answer:
I was thinking of using a betterment account and just setting it to 50/50 stocks and bonds sound good? Or I could do Vanguard and do the same thing, what funds would you choose with this option? Which option do you prefer? Why?
Is my 50/50 allocation stocks to bonds too aggressive considering our situation? Not aggressive enough? Keep in mind this is Efund/short term planning only, once we get to the point where we are maxing out retirement accounts (possibly never as I have access to 457b and 401k and make approx $48,000 gross)
Thanks for your opinions. Let me know if there is other info you need.
Edited: rewording
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I'm not a professional in this field so please don't consider the following expert guidance as it's just my opinions based on research for my own purposes. With that in mind, in your situation I don't see much benefit to Betterment as they are just a fancy Vanguard front-end that offers a few management benefits you don't really need for a fee. Your decision depends on your risk tolerance. If you want assurances that your savings won't ever go down, you can look at a high-interest savings account like Capital One 360 or Ally Bank, which both pay about 1%. Of course over the long term, inflation would eat into this and your "real" return (inflation adjusted/spending power) would be negative.
If you're willing to stomach some risk, Vanguard offers a few conservative all-in-one portfolios that can give you a simple, yet diversified, investment offering. VASIX or VTINX jump out, which are portfolios of other Vanguard Index funds (bonds, stocks, etc) combined to produce lower risk with moderate returns (4-5%). If you wish to be more conservative (which I'd probably suggest), you can invest a portion in these funds and the remainder in a short-term or inflation adjusted bond fund (e.g. VIPSX). Your returns would be lower, but that comes with the benefit of less risk. I do suggest short-term as you will be less susceptible to interest rate increases.
My general thought is if you invest you must be prepared to see your investment decrease periodically. If you're able to create a plan before investing a stick to it, the second option would probably be appropriate for you. If you will check the balance frequently and add tons of stress to your life with every movement, the additional returns are NOT worth it, and probably won't be realized as you may convince yourself to sell as soon as the market drops. Good luck to you
<Edit to specifically answer your question - I do think a simple 50/50 allocation is too aggressive for your stated needs>
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For one thing with a Roth IRA you'll run into limits on contributions. You can however withdraw contributions tax free.
I would encourage you to have a true emergency fund in a more safe and liquid spot, such as CD or savings account. This could be just a smaller amount than the 35k you're looking at.
Also what basis are you using for the 35k amount? That's a large chunk of change. It's cool if it's something that has some meaning behind it or is calculated in some way, but if it's just a random number you may want to be a bit more systematic on your approach.
There is no need for Betterment. A 50/50 portfolio is so simple there isn't a reason to pay someone else to do that for you. You have to keep in mind that you'll be paying taxes on anything you pull down. A taxable event may erase any sort gains you get in such a portfolio, make sure you understand this as it is meant to be an emergency fund. You may just blow a ton of money on taxes if shit hits the fan.
Like you said Emergency funds/short term funds need to be liquid and safe. That does not describe taxable accounts to me.
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Ditto the comments about your plan for the E fund being very aggressive in terms of % in stocks and overall size.
Why doesn't your partner apply for disability now if illness is preventing them from getting another job?
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My basic rule is to treat so called emergency funds similar to other investment funds -- i.e. as part of your investment portfolio.
Should you need these funds the worst case is generally they will be down 40% from their initial value. This would mean you put them in at the top and the emergency magically happened at the bottom and required all the funds. A very unlikely (less than .02%?) scenario.
A more likely worst case would be that you invest at the top and then an emergency happens at the bottom but you need to only draw out some funds over a 12 month time period giving some time for market bounce back. In that event you might be in total down 20% from the top.
The most likely scenario however is that your investment account is up substantially up from the funding date. (what 70% likely?)
So if you are nervous, simply allocate an additional 40% to the "emergency investment account" all in low fee index funds. So instead of 35K allocate 50K. It may take you a few more months to do so.
You will be very happy with this approach and over a 30 year period you will literally have millions of dollars more than if you had kept your EmFund in a savings account paying zero.
And by the way --- all invested money is essentially emergency money in reality. Your kid has a disease that requires 500K in treatment costs and you are cashing out those investment accounts.
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Thank you all for your replies.
I am not sure if i was clear but I do not currently have the money for this account $35,000 is a goal towards which to direct the money that I currently am using to pay down debt, once that debt is paid off.
Tjat - I have a fairly high risk tolerance so I don't foresee pulling money out of the account because of a downturn just for an emergency.
Matchewed - I do have a basic emergency fund of a few thousand already. So far it has covered the emergencies we have had. But would not be the solution for larger emergencies or job loss.
I chose $35,000 because that is what we spent last year. However, it includes things like debt repayments, emergencies, and some 401K deposits. I will need to reevaluate the numbers as I save, which will be a long process. You are right that it is likely too large. How would you decide how much to keep in this kind of Efund?
I agree with you somewhat that an Efund should be safe but the idea of a large amount of cash in a bank account seems wasteful. I don't plan to pull money from this account unless tragedy strikes or huge major repairs are needed.
Plain Jane - what percent of stocks/bonds would you suggest? Also how would you decide what amount is appropriate?
As for applying for disability, this is an ongoing issue. On one hand if something happened to me he would have my retirement accounts ( not a ton at this point) and life insurance that is 2x my salary. If he can't ever work again this isn't enough. On the other hand if he were granted SSDI right now we would just end up saving the money which obviously would be great for our long term goals but feels like we would be gaming the system. I would like to hear people's thoughts on this.
Bob W - thank you for your thoughts. In the long run, once I have the Efund funded I may be comfortable being more aggressive. If DH were to get SSDI I think my tolerance would rise since much of my worry is directly related to the "what if something happened to me?" Scenario.
I apologize for misspellings and poor grammar I am typing on my phone.
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Matchewed - I do have a basic emergency fund of a few thousand already. So far it has covered the emergencies we have had. But would not be the solution for larger emergencies or job loss.
I chose $35,000 because that is what we spent last year. However, it includes things like debt repayments, emergencies, and some 401K deposits. I will need to reevaluate the numbers as I save, which will be a long process. You are right that it is likely too large. How would you decide how much to keep in this kind of Efund?
I agree with you somewhat that an Efund should be safe but the idea of a large amount of cash in a bank account seems wasteful. I don't plan to pull money from this account unless tragedy strikes or huge major repairs are needed.
Depends on where you are in your financial journey, your risk tolerance, your odds of an event happening...etc. Things to consider though; time to find a new job in the event of a job loss, odds of an emergency trip (things like needing to visit a parent), odds of needing to buy a car or repair a big thing...etc. These are things I can't answer for you and are particular to you and your life. This will guide you in framing your EF.
Again as I said while your emergency fund is small and you're saving you need it safe. As your net worth starts increasing your odds of damaging your financial picture via needing to dip into your net worth decrease. Essentially when you have more money you don't need to have as much of an emergency fund (if that's your risk tolerance).
Re: disability, the system is designed just for this. You aren't abusing the system by using it as it is intended. It's meant to help households just in your situation. Use it. You'll FI quicker and there would be a support system in place if something were to happen to you.
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E Funds go into low risk buckets. $30k is a very small amount of your total FIRE net worth so either you have a long ways to go before retirement or you're putting in LARGE sums of money away for early retirement. Which is it?
It's just an insurance policy you're creating for yourself is all. I'd hate to lose my job and %40 of my EF at the same time.
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I am in pretty much the first steps of my financial journey. When I first started working I never even thought about the possibility of early retirement but I did put 10% of my salary into 403b at that job, unfortunately the salary started at less than $20,000. I did that for 5 years from 2002 - 2007 then I went back to school and so no contributions. My next job didn't offer 403b until you worked for 1 year but at that point I knew I was leaving so no contributions. Then I started my current job but didn't start contributions until last year because that is when I decided to take control my financial situation.
This is my financial picture as it stands. T = total Y = 2015 yearly contribution
Pension - $? t, $3,421y - nothing I can do about this... wonder if it will exist when I retire
457b - $35,000t, $3,510y
DH401k - $1,000t, $2,000y - to maximize savers credit
debt - $5,600t, $4,920y (this is just my planned payments but I also throw any extra money here, this is also the money that will be redirected into the Efund) so far this year we have already paid $3,000, so the debt should be retired soon
In my checking account I always have 1 full month of expenses, thanks to YNAB. I also have some money sitting there for a rainy day designated as follows:
House maintenance $1,000
Car maintenance $217 just did some maintenance on the car
Health $527
Emergency fund $1,000
Anyway, I usually keep all of these topped off at around $1000 but we have recently spent money in these categories so they are low. As they build back up I am looking at hitting the limit on earning interest on my checking account (2.4%) so I don't want to keep more than that in cash. This amount of money would cover most minor and even medium sized emergencies so my goal for the larger Efund is really BIG emergencies and also a place to stash medium term savings. As I put more money into my 457b job loss will become less and less of a worry since I can access that money right away if needed.
My long term goal at this point is not early retirement, I love my job, but FI. I want to know that I don't need to work so that our future is planned for and that if one day I hate my job I can just leave.
DH has actually already applied for disability after his doctor told him that he should. But every time he gets a letter in the mail the conversation goes back to "do we need this?", "is this okay?", "am I giving up?" there are a lot of emotional factors involved and tbh it is just weird.
This is really helping me think through this. I have at least a few months before I pay off the debt and can put money away.
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You have yet to define what a "BIG emergency" is. As long as you put it out there as some scary big event you'll continue to view it as a necessity to have such a large amount as an emergency fund without knowing whether you actually need that amount as an emergency fund. Define your emergency fund. That will tell you how much you need and where to put it.
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I'd suggest you rethink 35k as your goal for the EFund if that number includes things you wouldn't be doing if you lost your job. For my personal comfort level I used to have ~6 months of cash in a savings account. But that was 6 months bare bones cash, not 6 months with some meals out and clothing and books and a daily commute. Once that was about 10% of our investable assets I dropped it to ~3 months cash because I knew that if things really got bad for a prolonged period, we could go into that other account and not be pulling out too big a proportion while it was likely down.
Once you've got a barebones Efund, start actively investing for FI with a 60-40 or 70-30 allocation. But I think your base EFund should be cash until you have enough money overall to weather a bigger storm. And you should figure out the size of your EFund by calculating what you will need to be spending in that scenario, not what you've spent in the past. (E.g. my Efund size assumes we're both out of work, but healthy and not needing to travel to take care of family members.)
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My approach is different from most of the folks on this forum. I keep a 100% stock allocation, but at the same time, keep my emergency fund on the high side, mainly because I am a single household and my job would be difficult/impossible to replace. I keep one year's expenses, plus a dental fund (the same amount I used to pay for dental insurance) plus a slush fund (low cost vacations plus variations in expenses).
My approach is two high yield checking accounts. One pays 2.5% ($25 k max.), the other pays 3.05% ($20K max). This way, the EF "keeps up with inflation". The cost of this is being disciplined, vigilantly 'firewalling" the emergency accounts on a spreadsheet (or whatever method you come up with), 10-12 debit card transactions per month each (you have to track the statement cycles), and E-statements only (not a problem). These are "kasasa" accounts (kasasa.com). You would need to find a bank that does business in your state (it used to be easier via an app they had where you enter your zip code....I don't know what happened to it...).
It's basically a hack, that I've "got down", and it 's not for everyone (about 1.75% extra yield) and with a couple, would require a lot of coordination.
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Thanks for all your responses. I guess the hard part is figuring out what we would need beyond just bare bones for 6 to 9 months. This is year has been nuts for house repairs. We had over $3,000 in plumbing repairs and our AC just went up so we are getting that fixed. Luckily we had been saving for home repairs so we could pay for it.
I guess that is the part I am having trouble figuring out how much I should save for those types of emergencies. Beyond just what we need to survive.
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Matchewed - I like your suggestion to define the refund. I guess if I were to do that I would say I want it to cover bare bones expenses and a new roof (when I think of scary, nebulous emergencies this is the big one in my mind)